Strategy Note By Leading Experts: 12 Warning signs of equity markets globally topping out

 The minutes of the Federal Reserve’s July meeting, released on Aug 19, showed the members cut their economic growth forecast for the remainder of 2020 and stressed the need for more fiscal aid in the wake of the coronavirus pandemic. The Fed minutes echoed earlier warnings by Fed Chair Jerome Powell about the significant downside risks to the economy which remains tethered to the pandemic’s trajectory. The policy committee said that the swift rebound in employment seen in May and June had likely slowed and that additional “substantial improvement” in the labor market would hinge on a “broad and sustained” reopening of business activity. The Fed also ruled out for now more dovish monetary policy measures such as yieldcurve control.

 China kept its benchmark lending rate for corporate and household loans steady for the fourth straight month at its August fixing on Aug 20.

 After struggling for 5 days from Aug 11, S&P 500 ultimately managed to reach an all time high on Aug 18, but did not continue on the upside on the next day. The CBOE VIX after making a recent closing low on Aug 17, seems to have turned up from Aug 19. This suggests that caution could be returning to the markets.

 Gold futures after making a record high on August 07 ($2089/ounce) fell and made a lower high on Aug 18 ($2024.6/ounce). It fell sharply later in a day to $1930.50/ounce. Gold has been rising on the back of low interest rates and safe haven demand.

 Post the US Fed meeting minutes release, it seems that the Fed is done with the monetary easing process for now. Hence the interest rates could inch up from here across the globe. In such an event, the lure of equities and Gold could fall.

 US 10 Year Bond yields also made a low of 0.504% on August 06 and refused to go further lower. It recovered sharply to 0.727% on Aug 13.

 Apple touched market cap of $2 trillion on Aug 19. This is above the GDP of quite a few nations and is also almost equal to the entire marketcap of Indian listed universe. This is the extreme example of polarization of markets where big become bigger at the cost of a lot of smaller players.

 US China tensions are rising with cancellation of US China trade talks, the US State Department asking colleges and universities to divest from Chinese holdings in their endowments, further tightening of restrictions on China’s Huawei Technologies Co and fears of China retaliating in some form against China. While a lot of these can be part of election rhetoric, one does not know if and when the situation goes out of control.

 US Dollar index has been weakening since May 2020 before recovering mildly off late. Although there is no clear past correlation between dollar index and stock indices, the volatility in the index can create turmoil in a way that cannot be
anticipated now.

 The pending US elections in November could also create uncertainty. Some people think that if there is a Democratic sweep in the November election, many of Trump’s policies will be reversed and taxes will increase. Based on that analysis, they feel that stock market could fall about 20%. Joe Biden, the democratic candidate, has a lead over Donald Trump at this point. However in case liquidity continues to be aplenty, then markets could overcome any outcome of Presidential elections.

 The moot point is whether the central banks are inclined to keep the liquidity spigots open for ever even when the past infusion does not seem to have had the intended impact. This is one key determinant for the stock market trajectory from here. Going by the Fed minutes, it seems that the end of monetary easing seems near. Markets could turn down before that if there is sufficient consensus or anticipation about this happening.

 In India the Nifty P/E is at atleast a 10 year high while the ground level situation, the financial sector stress and macro situation leaves a lot to be desired.

 The idea behind this note is to caution against building fearless longs and advise taking some profit off the table. While the liquidity spigot may not be turned off immediately and this may result in the party in individual stocks continuing, the risk reward on broader markets does not seem too favourable.